Freedom Day and democratic transition

American Law and Economics Review

By Robert P. Inman and Daniel L. Rubinfeld

Despite the recognized virtues of democratic rule, both for protection of personal rights and liberties and for economic progress, the current list of world governments still classifies 46 of all countries, or 25%, as dictatorships. Rulers in these existing dictatorial regimes resist the transition to democracy, often at a high cost each year in lives and resources. One would hope that the potentially sizeable benefits of democracy could be shared to the mutual advantage of the once ruling elite and the poor majority. The gains are there, why can’t they do a deal? The answer turns on the inability of a new democracy’s poor majority to credibly promise the elite that they will not be exploited once democracy becomes the new order.

Yet, in one of the most important political events of the 20th century, South Africa solved this problem. In April 1994, Nelson Mandela was elected President of the new Republic of South Africa, and on 11 October 1996, a democratic constitution was approved unanimously by the National Parliament with the full support of the once autocratic National Party. In President Mandela’s words the new constitution offered the citizens of South Africa “a democratic government… that (has) an inbuilt mechanism which makes it impossible for one group to suppress the other” (speech by President Mandela, Stellenbosch University, May 1991). That built-in mechanism was federal governance, of a particular kind.

How can federal governance using both democratically-elected national and state or provincial governments provide the essential protections for the elite needed for a peaceful transition from autocracy to democracy? Three elements are necessary. First, having given up political and military control, the old ruling elite will need to find its future influence in another way — through the economy, perhaps. Since land and machines can always be expropriated, it will have to come from the labor skills of the elite that the majority will need but cannot import or master quickly on their own. In South Africa these elite skills were found in the provision of public services, and in particular, in health care, education, and efficient public administration.

Second, the elite must be able to withhold these needed skills if the majority threatens to expropriate elite-owned land, nationalize elite-owned firms, or to set tax rates on income at excessive rates. It is often thought that the elite’s ability to migrate would be a sufficient deterrent to expropriation or excessive taxation. In South Africa, migration from the country has been modest. You cannot take land and machines with you when you leave, and for all but the most talented, comparable jobs in a new homeland may not be readily available.

What then is an alternative way to withhold needed talents? Perhaps a “strike” or a “work slowdown” organized through elite control over the provision of essential government services? But since the elite is now a political minority, it cannot be a country-wide slowdown. However, it can be a slowdown in one important part of the country where middle and upper income households might constitute a political majority. Local political control could be assured by a constitution that creates provincial governments and draws the provincial borders so that first, there are enough new (lower income) majority residents in the province so that the majority-run national government cares what happens to these constituents, but second, not so many that the middle and upper income households lose political control over the province. We call this requirement the Border Constraint and it must hold so that the elite controls at least one or two important provinces in the new democracy. In South Africa, that important province has become the Western Cape, home of Capetown and South Africa’s wine country. Further, so that this local control can be used as a credible deterrent to excessive national taxation, the provinces must be assigned responsibility for providing important public services. We call this requirement the Assignment Constraint. In South Africa, these constitutionally assigned services are primary health care, K-12 education, and the administration of social security payments.

Third and finally, the elite-run provinces cannot become economic islands unto themselves, as indeed the National Party had originally proposed during constitutional negotiations. President Mandela and the ANC rejected this approach to federalism by insisting that all important taxing powers remain in the hands of the national government. But without significant taxing powers, how can provincial governments provide important public services? The answer is the last element in the design of the federal constitution: a clearly specified formula for sharing national tax revenues with the provincial governments. In South Africa’s constitution, this formula is called the “Equitable Share” and is recommended each year by a constitutionally protected commission called the Financial and Fiscal Commission composed of representatives from each of the nine provinces.

The elite’s expertise in the provision of important public services, empowered through an appropriately designed federal constitution, gave Nelson Mandela the “inbuilt mechanism” he needed to assure F.W. de Klerk and the National Party that their economic interests could be protected in the new democracy. Having fashioned a federal constitution for South Africa’s democratic transition, and it is holding so far, who has benefitted?

Crime and unemployment remain serious problems, but crime rates are no higher than those in many of the largest US cities and there is a thriving black market for those who are formally unemployed. Taxes on middle and upper income households have increased to finance expanded public services to lower income households, and there remains an important significant inequity in the distribution of education, health care, and infrastructures. All said, while pressures on education and other public services have continued to grow, tax rates are still below our estimates of maximal taxation and there have been no exploitive land transfers or wholesale nationalization of private capital. Adult disability and child mortality rates continue to fall, new lower income housing is being built, school enrollment is up, class sizes are shrinking, and literacy has increased. When we compare what lifetime earnings would have been for the majority of South Africans had apartheid continued (with negative growth!) to earnings today and into the foreseeable future, the typical poor majority resident has become 160,000 Rand ($20,000) richer and the typical elite resident about 350,000 Rand ($45,000) richer over their lifetimes.

To be sure, South Africa continues to face important challenges to its economic and political futures, but there is little doubt that by almost any measure of personal welfare, the average elite and majority resident are better off today than they might have been under the continuation of apartheid. Our argument here is that federal governance, appropriately constructed, made this possible. Perhaps South Africa’s experience holds lessons for others seeking a peaceful transition to a stable democracy.

Robert P. Inman and Daniel L. Rubinfeld are the authors of “Understanding the Democratic Transition in South Africa” in the American Law and Economics Review, which is available to read for free for a limited time. Robert Inman is the Richard K. Mellon Professor of Finance, Economics, and Public Policy at the Wharton School, University of Pennsylvania. Daniel Rubinfeld is the Robert Bridges Professor of Law and Professor of Economics, Emeritus, University of California, Berkeley and Professor of Law, New York University School of Law. Professors Inman and Rubinfeld served as economic advisors to the Financial and Fiscal Commission and to the national government’s Departments of Finance, of Education, and of Welfare on matters of fiscal policy for the period 1994-2000.

The American Law and Economics Review is a refereed journal which maintains the highest scholarly standards and that is accessible to the full range of membership of the American Law and Economics Association, which includes practising lawyers, consultants, and academic lawyers and economists.

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